Eswar Prasad: Will the future of money be a better, fairer one – or is the path ahead more dystopian?
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Eswar Prasad: Will the future of money be a better, fairer one – or is the path ahead more dystopian?

New innovations of digital payments not only have the potential to democratize finance, dramatically improving financial access for savers and easing global economic integration, but also pose risks, including many that regulators may not even be looking out for.

We sit down with a top academic thinker, Eswar Prasad, Tolani Senior Professor of Trade Policy, Cornell University; Senior Fellow, Brookings Institution; former Head, China Division, International Monetary Fund, to discuss what an entirely digital financial system could look like, and how it will shape economies and societies.

Eswar Prasad, Tolani Senior Professor of Trade Policy, Cornell University; Senior Fellow, Brookings Institution; former Head, China Division, International Monetary Fund

The AIC is celebrating its 25th anniversary this year. Clearly 25 years ago nobody was talking about digital currencies, so the pace of change has been fairly rapid. In 25 years’ time, will the future monetary system be a radical departure from today’s society, or a new iteration?

Eswar Prasad: After a long run that lasted for many centuries, the era of cash is finally drawing to an end. Digital payments are rapidly becoming the norm around the world. The rise of CBDCs is a foregone conclusion and, with their greater convenience, CBDCs will almost certainly precipitate the disappearance of cash within a few years. Cryptocurrencies and the technological advances that they represent are going to make payment systems more efficient, but decentralized cryptocurrencies are unlikely to serve as viable long-term stores of value.

One important change on the horizon is the separation of the various functions of money, with central bank–issued currencies retaining their importance as stores of value and, for countries that issue these currencies in digital form, also retaining the medium of exchange function. Still, privately intermediated payment systems are likely to gain in importance, giving central banks a run for their money.

In the long arc of history, these changes will imply a return from the dominance of official currencies to renewed competition between private and fiat currencies. Competition between various forms of privately created money and central bank money in their roles as mediums of exchange will intensify, particularly as the barriers to entry are low. In principle, intensified competition between currencies should lead to payments that are cheaper and quicker, benefiting consumers and businesses, and also foster incentives for issuers, whether private or official, to exercise discipline in order to preserve the value of their currencies.

China has been trialing its own Central bank digital currency – the e-CNY – including at the recent Winter Olympics. Will CBDCs help or hinder central banks when it comes to monetary policy?

Eswar Prasad: The basic mechanics of how monetary policy is managed will not be affected by a switch from physical currency to CBDCs. Other technological changes likely to affect financial markets and institutions could, however, have significant effects on monetary policy implementation and transmission. For instance, the proliferation of digital lending platforms could reduce the prominence of traditional commercial banks. When a central bank changes interest rates, it affects interest rates on commercial bank deposits and loans in a way that is reasonably well understood. The corresponding effects on the lending rates of other institutions and platforms are much less clear. This makes it harder for a central bank to manage the economic variables it cares about—inflation, unemployment and GDP growth.

If account-based retail CBDCs lead to a disintermediation of the banking system, monetary policy implementation and transmission would certainly be affected. But CBDC experiments underway in China, Sweden, and elsewhere show that these risks can be substantially mitigated through suitable design of CBDCs such that they will not serve as direct substitutes for bank deposits.

CBDCs will not change some fundamental aspects of monetary and financial systems, however. The issuance of CBDCs will not mask underlying weaknesses in central bank credibility or other factors, such as a government’s undisciplined fiscal policies, that affect the value of central bank money. When a government runs large budget deficits, the presumption that the central bank might be directed to print money to finance those deficits tends to raise inflation and reduce the purchasing power of central bank money, whether physical or digital. In other words, digital central bank money is only as strong and credible as the institution that issues it.

Cryptos cannot in any significant way prevent a country’s currency from collapsing in value relative to major reserve currencies since those values are determined in formal financial markets.

The sanctions imposed on Russia have ignited an interesting debate around the use of digital currencies which are not controlled by any government or central bank, but are more traceable. Is a truly decentralized, anonymous monetary unit a desirable outcome?

Eswar Prasad: Cryptocurrencies do not yet provide the scalability to evade financial sanctions at the level of an entire economy, especially in view of the need to ultimately convert cryptocurrencies into more widely-accepted global currencies to make international payments. Furthermore, cryptocurrencies cannot in any significant way prevent a country’s currency from collapsing in value relative to major reserve currencies since those values are determined in formal financial markets.

While cryptocurrencies might be seen by a country’s citizens as a better option than a plunging domestic currency or as a conduit for capital flight, the reality is that they do not provide a reliable and scalable workaround for a national government to bypass the international monetary system.

Cryptocurrencies might in fact hurt Russia if they are seen by the country’s citizens as a better option than the plunging domestic currency. Thus, Bitcoin might end up precipitating a flight of deposits from Russia’s banking system and even as a conduit for capital flight out of the country.

Bitcoin, the original decentralized cryptocurrency, was designed to serve as a pseudonymous medium of exchange that could be used for financial transactions without relying on central bank money or a trusted intermediary such as a commercial bank or credit card company and using only transacting parties’ digital rather than real identities. The notion of increasing payment efficiency and reducing costs by cutting out intermediaries seems an attractive proposition.

Bitcoin initially fueled the dark web, where illicit commerce was conducted. As Bitcoin gained in popularity, it became apparent that its users’ anonymity could not be guaranteed. Moreover, Bitcoin’s unstable value renders it an unviable medium of exchange. Transactions using the cryptocurrency are slow and expensive. The Bitcoin network also cannot process large transaction volumes in a timely manner.

While it has failed in its stated objective as a pseudonymous medium of exchange, Bitcoin has somewhat paradoxically turned into a purely speculative financial asset. Such decentralized cryptocurrencies could end up posing risks to the traditional financial system, especially if these assets are acquired by unsophisticated retail investors who get taken in by the allure of the new technologies and do not understand the risks associated with cryptocurrencies.

Why do you believe blockchain holds so much potential? What risks do you foresee in a society where digital currencies are the main form of value?

Eswar Prasad: Cryptocurrencies do not yet provide the scalability to evade financial sanctions at the level of an entire economy, especially in view of the need to ultimately convert cryptocurrencies into more widely-accepted global currencies to make international payments. Furthermore, cryptocurrencies cannot in any significant way prevent a country’s currency from collapsing in value relative to major reserve currencies since those values are determined in formal financial markets.

While cryptocurrencies might be seen by a country’s citizens as a better option than a plunging domestic currency or as a conduit for capital flight, the reality is that they do not provide a reliable and scalable workaround for a national government to bypass the international monetary system.

Cryptocurrencies might in fact hurt Russia if they are seen by the country’s citizens as a better option than the plunging domestic currency. Thus, Bitcoin might end up precipitating a flight of deposits from Russia’s banking system and even as a conduit for capital flight out of the country.

Bitcoin, the original decentralized cryptocurrency, was designed to serve as a pseudonymous medium of exchange that could be used for financial transactions without relying on central bank money or a trusted intermediary such as a commercial bank or credit card company and using only transacting parties’ digital rather than real identities. The notion of increasing payment efficiency and reducing costs by cutting out intermediaries seems an attractive proposition.

Bitcoin initially fueled the dark web, where illicit commerce was conducted. As Bitcoin gained in popularity, it became apparent that its users’ anonymity could not be guaranteed. Moreover, Bitcoin’s unstable value renders it an unviable medium of exchange. Transactions using the cryptocurrency are slow and expensive. The Bitcoin network also cannot process large transaction volumes in a timely manner.

While it has failed in its stated objective as a pseudonymous medium of exchange, Bitcoin has somewhat paradoxically turned into a purely speculative financial asset. Such decentralized cryptocurrencies could end up posing risks to the traditional financial system, especially if these assets are acquired by unsophisticated retail investors who get taken in by the allure of the new technologies and do not understand the risks associated with cryptocurrencies.